Sterling surges though UK-EU gap remains "quite wide"

Reports suggest that UK and EU negotiators were moving closer to a Brexit deal

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Reports that UK and EU negotiators were moving closer to a Brexit deal on Tuesday afternoon have re-charged cross-asset rallies across the Continent and British-tied shares, even as both sides continued to pepper rising optimism with caution.

Key points

The UK reportedly submitted revised proposals on Tuesday to bridge an impasse that opened at the weekend, after a ‘pathway’ to an agreement opened up during talks between Boris Johnson and Ireland’s Leo Varadkar

The new proposals centre on clarification of custom arrangements for Northern Ireland, according to reports

The exact sticking point appears to be the extent to which Northern Ireland will be separate from the EU’s customs union

If reports are accurate, it looks like it is the shape of the eventual 'fudge' that’s being discussed, for want of a better word. Remember, the key difficulty around alternative proposals to the backstop has always been coming up with arrangements that respect, if not resolve a key conundrum: how to maintain trading standards and regulations the lightest of quasi-customs arrangements that are acceptable to both the EU and UK.

As ever, it’s all too easy to see how even the promising progress that’s emerged from reports could evaporate, as has happened in the past. Unsurprisingly, none of the key protagonists are entirely giving in to unanchored optimism.

Referring to earlier in the afternoon, Ireland’s Varadkar noted that the gap in agreement over customs remained “quite wide”

The latest talks have been “constructive”, though there’s more work to do, the PM Johnson’s chief spokesman, James Slack noted

That anticipates the next challenge, where any deal will have to win over the DUP, the unionist Irish party that lends conditional support to Britain’s Conservative government. Johnson is said to be “confident of getting the deal through” Parliament, if it can be agreed with the EU, with “ongoing dialog” between the prime minister and the DUP conveyed by his spokesman. Under the circumstances, the EU’s informal midnight deadline for deciding whether a viable deal is in the offing might be allowed to slip somewhat. Markets in their current state of excited anticipation would probably react favourably.

Tuesday’s key market reactions so far

Shares extended gains across the EU, though Ireland's ISEQ All-Share rose most, with a 2.5% rise

The FTSE 250 index, laden with groups dependent on the UK for most of their revenue tacked on 1.3%

The DAX rose more than 1% to its highest since August 2018; the broad STOXX 600 reached its best levels since May 2018

Even the FTSE 100 threatened to erase small losses in favour of small gains. Sterling gains typically drag on the FTSE's global exporter shares, due to the perceived pressure on their revenues

FX markets have expressed resurgent optimism via both the pound and the euro. Sterling advanced as much as 0.8%, with the single currency getting as high as 0.5% off lows

Clearly, the market reaction itself puts even more at stake should talks look like they might falter. Even if the deal gets across the line in Brussels it will then face a Parliamentary vote, after MPs voted down former Prime Minister Theresa May’s deal three times, before defeating Boris Johnson many more times. For sterling in particular, perhaps Wednesday’s inflation figures may turn out to be the least of its problems, regardless of how far away they are from expectations. Overall, the pound is no less volatile this week. Short-term volatility indicators have risen for four straight sessions.

On the charts, the pound has pierced its closely watched 200-day moving average for the first time since late April. However a key level we have been watching as a gauge of how convinced sterling buyers really are—$1.278, a failure high from June—has been tested though not sustainably breached. Like deal prospects, sterling’s chances of a lasting recovery are buoyed, though still quite in the balance.

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